Telecom companies are boring companies. In many cases, they are viewed as cash cows with limited room for growth. After recognizing this problem, telecom companies have attempted to diversify into other areas, but their track record of diversification has been patchy best keyword AT&T and Verizon. No wonder investors are very skeptical and stay away from this industry (it has the 3rd lowest EV/EBITDA score in the industry behind coal and upstream oil & gas).
Amid patchy track records of diversification, there are some outlier telcos that are characterized by well-executed entry into new high-growth sectors. Turkcell (NASDAQ: TKC) is one of the outliers.
With the share price near an all-time low of $2.97, TKC is trading at an attractive valuation. TKC has all the hallmarks of a well run company: credible market leader, solid balance sheet and diverse growth opportunities. However, given the significant near-term sovereign risk, I would rate TKC as a watch-list buying opportunity.
1H FY22 financial report
In 1H FY22, TKC reported stellar double-digit growth rates. However, the numbers need to be constantly checked on a USD basis, especially for investors looking to invest in USD-denominated ADR shares.
Table 1: Turkcell’s 1H FY22 vs. 1H FY21 Financials in TL & USD ‘M
Once the depreciation of the lira against the USD is factored into the YoY comparison, the picture looks very different. The devaluation of the lira over the past year has negatively impacted sales and profitability in USD terms. Year over year, revenue fell 25%, EBITDA fell 27%, and net income fell 36%.
Despite the negative performance in FY22, TKC remains an intriguing investment opportunity with (i) quality operator, (ii) solid balance sheet and (iii) successful diversification into high growth sectors
Best in class operator
Figure 1: Mobile market share in Turkey
TKC is the dominant telecom operator in Turkey with the highest subscriber market share in the mobile market. While the market share has declined from a peak of 57.1% in 2009, it has since stabilized at ~41% in recent years (see Figure 1). Management has pulled off this feat by focusing on service, which has caused the churn rate to drop from a peak of 34% in 2010 to 2% in 2021.
Figure 2: Turkish Mobile ARPU in TL per User
TKC’s dominance is also reflected in the increase in ARPU compared to its competitors. TKC has been able to carve out a niche for itself, probably gaining more consumer loyalty through a combination of better wireless service and bundled offerings.
TKC has a solid balance sheet with little debt. As of Q2 22, TKC’s net debt to EBITDA ratio is a manageable 1.2x. Additionally, with a net exposure of $149 million, the debt is well hedged against currency fluctuations, with the majority of the debt (62%) maturing in 2025 and beyond. TKC management has also strategically repurchased USD 7.3 million Eurobonds at a discount of 8-10% to face value. Overall, TKC’s balance sheet is well positioned to withstand the negative impact of further lira depreciation.
Successful diversification into high-growth industries
TKC has diversified into 3 key areas: 1) Digital Services, 2) Digital Business Solutions and 3) Techfin Services.
Table 3: Top ranking of Turkcell apps
Among digital services, TKC has several top mobile apps in several categories in Google Play Store (Android’s market share in Turkey is 85%). The digital services segment saw strong growth, with revenue growing 31% year-on-year in FY21. The company is also actively expanding its services through partnerships abroad.
Digital business solutions and Techfin services have seen growth leaps and bounds in Q2 2022. Revenue from the former is up 85% year over year. In the latter, Paycell (payment app) revenue is up 78% and Financell (digital loan provider) revenue is up 65%.
As Turkey moves towards increasing digitalization, these new business segments are well positioned to continue their strong growth trajectory.
While Turkcell is a solid company that has diversified into new high-growth sectors, investors need to be wary of increased sovereign risk.
Continued devaluation of the lira
Turkey’s President Erdogan has done everything to prioritize growth over curbing inflation. Aside from the interest rate cut (high from 19% in March 2021 to 13% in August 2022), skyrocketing energy costs have also contributed to a significant depreciation of the lira (37% drop vs. USD YTD). In addition, the Turkish central bank has limited reserves to defend the currency. It’s a perfect storm for further lira down (Fitch forecasts the lira to fall from 18 to 20 against the USD by the end of the year).
Coming political uncertainty
Erdogan’s pro-growth policies are aimed at putting him in a position to win the upcoming presidential election in June 2023. In the wake of persistently high inflation, popular dissatisfaction with Erdogan’s rule is high. Early polls show that the AKP (Erdogan’s party) and its ally (MHP) are unlikely to win against a six-party opposition. Given Erdogan’s authoritarian record, he is unlikely to leave office peacefully, which could plunge Turkey into a period of political upheaval.
TKC is trading near its 5-year low in terms of NTM EV/EBITDA and NTM EV/sales. A return to 5-year moving averages would result in an average price target of $4.19, a significant 41% upside.
Table 2: Peer valuation comparison between local and emerging market peers
Turkish telecoms are trading at a significant discount to their emerging market peers. I believe the main reason is the rapidly depreciating lira, which positions foreign currency deposits or export-oriented Turkish companies as better investment opportunities compared to Turkish telecom companies. This valuation gap is likely to remain until the lira stabilizes.
Despite the attractive valuation, the country risk is too high to give a buy recommendation at this point in time. Nonetheless, TKC remains an excellent company to be on investors’ watch list to revisit when there is more clarity on Turkey’s economic and political situation (probably until the next Turkish elections on June 23).